The real issue

“While household debt has grown significantly, there does not seem to be any indication that it has yet become a risk to financial and overall macroeconomic stability.” — Economists Justin Carter, Winston Moore and Mahalia Jackman (2012)

On April 5, 2013 this newspaper featured an interesting article on its back page with the catchy title, “Deep Debt”. The authors of the paper (Is the Magnitude of Household Debt in Barbados a Problem?), which was the subject of the story rightly concluded that the level of household debt in Barbados is not a threat to financial or macroeconomic stability.

Though household debt in Barbados grew from $500 million in 1990 to $4.5 billion at the end of 2010, it is important to consider the context of that growth. If one reflects on the scale of domestic economic expansion (the economy more than doubled in size) during that period as well as the precipitous decline in unemployment, the rise in real income and the development of the local mortgage market, the $ 4.5 billion debt figure is not at all alarming.

As a matter of fact, it is indicative of a higher standard of living, especially when you consider that mortgage debt as a share of total household debt notably increased over the period as the housing stock improved and homeownership grew. More Bajans obtained a prized piece of the Rock; even as property prices advanced on account of the new effective demand for real estate. The introduction of 100 per cent mortgages and declining interest rates were major catalysts.

The truth is, Barbadian households are not in “deep debt” as the newspaper headline suggested. Two important findings of economists Carter, Moore and Jackman were (i) the size of household debt in Barbados as a percentage of GDP, a crude measure, is just below 60 per cent; and (ii) household debt net of savings was only about $1.5 billion in 2010.

The size of household debt in Barbados is favourably comparable to countries like Finland (54 per cent) and Germany (64 per cent), and much lower than in Ireland (121 per cent), the United States (99 per cent) and Spain (89 per cent).

What’s the significance of this comparison? Unlike Ireland, the United States and Spain to a lesser extent, Finland and Germany did not experience a 2007-08 financial crisis triggered by a collapsed housing market and the implosion of a debt binge. To support the point, the above mentioned economists quoted a recent IMF study that “showed that housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted”. That has not been and is not the case in Barbados. In terms of debt burden, Barbadian households are far better off than their government.

Moreover, average household debt in Barbados, which stood at $53,000, is significantly lower than average household debt in Canada which was CAN $114,400 in 2009 and growing. At that time, household debt in Canada stood at 150 per cent of disposable income. That means that for every dollar of disposable income, the average Canadian household had $ 1.50 CAD in debt.

You should be aware that Canada did not experience a financial crisis in 2007-08 and was relatively unscathed from the American-European financial crisis; suffering only a milder, shorter recession in 2008-09.

In March this year, Statistics Canada reported that the average Canadian household owes a record $1.64 for every dollar of after-tax income. Household debt in Canada is now a little lower than where US household debt was before the 2007-08 financial crisis, a fact that has attracted the attention of policy makers here in Canada.

Canada’s policy makers are seeking to prevent the prospect of financial instability brought on by: a plausible crash of the red hot housing market and/or widespread default on personal debt when the Bank of Canada begins to raise its overnight rate target from the one per cent low.

Canadians take on personal debt to purchase a new home, buy goods and services or invest in education but like Barbados the majority of the debt is mortgage debt.

On four occasions since 2009, Canada’s Finance Minister has tightened mortgage rules in an effort to curb household debt. Under Canada’s federal rules, mortgages for which the downpayment is less than 20 per cent of the purchase price must be insured against default. Since the vast majority of mortgage insurance is guaranteed by the federal government, the Feds have been able to act.

The government has gradually lowered the maximum insurable amortisation period from 40 years to 25, lowered the loan-to-value ratios that determine what can be borrowed by refinancing homes, and reduced the minimum downpayment. These policy interventions have begun to bear fruit. The housing market is showing signs of cooling and the growth of household debt has moderated.

In Barbados, the real threat to Barbadians’ standard of living isn’t household debt; the real threat is declining real household income. The spectre of rising interest rates is a secondary threat. Average household disposable income in Barbados has declined since 2009 due to rising unemployment, shorter work weeks in some industries, an implicit wage freeze, higher taxation and the steep rise in consumer prices during that period.

No one can deny that Barbadian households and businesses alike have begun to feel the pinch from declining household real income. Domestic interest rates are likely to trend upward in the medium term as government debt continues to balloon and international interest rates, which are currently at record lows, inevitably rise.

The number one policy objectives right now must be sustainable economic growth and public sector deleveraging, household debt is nothing more than a side issue.

* Carlos R. Forte is a Commonwealth Scholar and Barbadian economist with local and international experience.

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